The Oil Drum: Australia/New Zealand

I've seen a number of comments, both at TheOilDrum and elsewhere, suggesting that the US is now less susceptible to supply disruptions because we have reduced our demand for oil by several hundred thousand barrels per day over the past year. In general, I get the sense that people think we can insulate ourselves from supply disruptions, from our dependence on potentially unreliable foreign sources of oil, by improving our efficiency and eliminating "unnecessary" oil consumption. In my opinion, this is backward. In this post, I will argue that, because the demand that is destroyed first in a free market is the demand that is easiest to eliminate, the resulting consumptive system is more inelastic, more brittle, and more susceptible to systemic shock from supply disruption. I will approach this argument by outlining what makes a system either resilient or brittle and why market-driven demand destruction creates a more brittle system. I will conclude with a few thoughts on how we can increase the resiliency of our energy-driven economy in a future environment of declining energy supplies.

This is a guest post by Robert Smithson, a portfolio manager at a London based investment fund.

This is part one of a two part article on the economics of oil price demand. The second part looks at the economics of peak oil, and how the oil fits into an overall energy demand curve.

Introduction

“The world is consuming more oil than it is producing.” --The Economist, July 14-20 print edition.

Wow, that’s a shockingly foolish statement. Each day approximately 84 million barrels of oil are extracted from the earth, and approximately the same amount is consumed. It can be no other way: inventory space is limited, and could not be extended significantly by “excess production” or indeed drawn down for long by “excess demand”.

The problem is a basic lack of understanding of economics. And The Economist is hardly the only culprit.

(This is a post with the old comment thread for the post above...sorry to make you click back and forth...the new link is here.)